3. Cash flow statement

The third financial statement: the cash flow statement

The purpose of your cash flow statement is to measure your company’s inflows and outflows of cash over a given period of time, such as a month or a year.

There are two ways to estimate cash flows: the direct method and the indirect method.

According to the indirect method, the cash flow statement follows the below equation:

Investing and financing activities can meet short-term funding needs, but in the long run, cash from operating activities (the primary business activities) is the only reliable source to meet recurring cash needs. You can’t raise capital or take on debt to meet cash needs forever.

The indirect method is helpful for three reasons:

1. It provides a quick overview of what categories cash changes stem from (operating/financing/investing).

2. All the changes are driven by numbers that can be found in the other financial statements. The cash flow statement can be structured so that it automatically calculates the cash flow forecast if you have set up the income statement and the balance sheet correctly.

3. If you want to understand your cash change by investigating further, you can track the formulas from the cash flow statement back into the income statement and balance sheet.